Having your Cake and Eating it Too

Ask SmallIvy:  Please send to vtsioriginal@yahoo.com or leave in a comment.

The other day I came across a blog post from Mom Equity, who is a real estate investor living in the San Francisco Bay area who is chronicling her efforts to become wealthy – specifically to become a millionaire.  In the post she describes her apprehension during a month in which her spending is high.  She feels worried because a portion of her family income comes from sales of foreclosed homes, and therefore can be sporadic with good months and bad months.  This also makes it difficult for her to acquire assets, and thereby increase her income each month.

In the comments to her post she also talks about how part of her problem is spending – as it is for everyone.  No matter one’s income, there are always numerous things that are there, ready to take up whatever extra income you have.  For many people this extra spending even gets locked-in in the form of payments, subscriptions, and other recurring expenses.  In some cases it just become recurring out of habit, such as going out for breakfast after church or stopping by that coffee-house each day on the way home from work for the $7 latte.

Growing wealthy is very simple mathematically, but very hard emotionally.  It requires that you fight that urge to spend your extra income.  It requires that you patiently wait to buy the things that those around you are buying on credit when you have the money to pay cash.  This is why there are not a lot of wealthy people.  You must remember that no matter your income, you can’t outearn your capability to spend.

But by building pipelines – buying assets, you can have your cake and eat it too.  Taking her example where she has a certain fixed income component and then a fluctuating random income component, she could do this by doing the following:

1.  At the start, budget lifestyle to spend only the fixed income amount.  Each dollar should be assigned to a purpose starting with necessities and ending with niceties and then luxuries.  Normally a specific amount should be assigned to saving and investing as well, but because of her additional, fluctuating income component, this would not be completely necessary.

2.  All of the fluctuating income would then be available to purchase assets (this assumes an emergency fund is in place, otherwise one should first be built to handle unpredictable, random expenses).  By not using any of the fluctuating income for lifestyle, there would be no stress on months where the income did not materialize.

3.  As income from the assets starts coming in, a portion could then be used to add to the budget to allow lifestyle to expand, with the rest reinvested into more assets.  As time passes and the amount of assets grows, so can lifestyle.

This would require patience and not getting everything wanted now, but in the end she would have both the assets and the lifestyle.

It is a struggle for all of us to resist the urge to scale our lifestyle to our earnings, but by using some of the income from assets to gradually scale lifestyle, and having a plan to only spend money on luxuries that comes from assets, we can truly have our cake and eat it too.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

What Would Happen if your Income Stopped Tomorrow?

What would happen if your company laid you off tomorrow?  What if you work for the Government and the debt ceiling were not raised, forcing a sudden 40% cut, including your job?  Maybe you work for the FAA and the current controversy over the FAA reauthorization bill has caused you to be furloughed for the last two weeks.  What has happened?

When the credit cards come in the mail, will you have the cash to cover them?  What about your utility bills?  Your home mortgage?  Gas for the car?  College tuition bills?

Most people live from paycheck to paycheck.  They may be living the life of the affluent – going out to dinner at nice restaurants, buying all the stuff in SkyMall, going on lavish vacations to Disney World and Aspen – but if they were laid off for even a few weeks, their ability to pay their bills would suffer greatly.  Many might need to take the drastic step of cashing out 401K or IRA assets since that is the only store of money they have.  Maybe they have already done this during another “emergency” like a dead car or dead air conditioner.  Despite having tens of thousands of dollars flow through their hands each year, most people are broke.  Does this sound like you?

Let’s say instead you invested a little from each paycheck.  Maybe you were able to save $2500 or $5000 each year, outside of your 401K deposits.  You put aside $200-$500 per paycheck.  This was a sacrifice.  Maybe instead of getting the new car with the new car smell and the new car payments, you bought a $2000 Toyota Corolla with 150,000 miles and drove it for a few years.  After a few years you were able to save up enough, sell the Corolla for $1500 and combine it with another $2500 from your investments to buy a nicer 6-year old car with only 60,000 miles.

If you had been saving for 20 years, you might actually be making enough from your investments to offset your income entirely.  When you were furloughed, you cursed Congress for not working things out, but you had $10,000 or $20,000 in savings to draw upon.  You were able to pay the mortgage, the light bill, the gas bill.  What could have been a crisis was an inconvenience.  Instead of trying to find a new job at 40 after a layoff, maybe you decide to just go into business for yourself.  Maybe you decide to go back to college and start an entirely new career.  Because of your investing, you have these choices.

The sacrifice and investing in the quest for financial independence isn’t just for the greedy.  It is for everyone who wishes to reduce the worry in life.  It is for everyone who is responsible.  Everyone who never wants to risk being evicted due to a layoff or injury.  Hopefully the followers of this blog know and realize this.  Hopefully anyone new to the blog will think about this and maybe look at changing their financial picture.  There is nothing like not needing to worry about losing an income.

Your investing questions are wanted.  Please send to vtsioriginal@yahoo.comor leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Getting Rich through Stock Picking

It is often said that no one can beat the market, and yet individual investors do it all of the time.  No it is not the guy who is always talking about the market and his trades.  You know, the guy who is always checking his blackberry for stock quotes and telling about his victories and war stories.  It is the one who quietly builds up large positions in companies and holds onto them as they grow.

Growing wealthy through stock picking is very similar to growing wealthy by starting your own company.  When starting a company one chooses an idea, finds some starting money, and then works hard to make the business grow.  Often substantially all of one’s money is in the business.  With a lot of hard work, some good management of finances and payrolls, a good idea and a bit of luck, one can become wealthy through one’s business.

Growing wealthy through stock ownership is a similar process, except the hard work is eliminated – traded, actually, for loss of control over the company.  Luckily, however, you can take advantage of professional managers with graduate degrees from ivy league universities – the type of management team you would never be able to hire on your own.  The trick is to think like you are becoming a partner in a business rather than trading stocks.

When one trades stocks one is generally concerned with price movements.  If the stock is moving up in price, one will hold on, perhaps taking a bit of profit by selling a few shares on the way up.  When the stock appears to be peaking, one will sell to lock in the profit before the price retreats.  Often this results in one selling out of profitable positions too soon or even buying stocks near peaks and selling them after sharp sell-offs.  This is an exciting way to invest, but generally it will result in little profit.  If one is lucky one will tie the market.  In general, however, the additional tax and trading cost burden of moving in-and-out of the markets will result in substantially lower returns.

When one buys like a partner, one is taking a long-term stake in the company.  The price really doesn’t matter much, as long as it is not too great when buying in to make the profit potential unappealing.  One expects the price of the stock – the sale price of the business – to fluctuate with time.  One does not care so long as the business is growing and prospects for it becoming more valuable in the future remain bright.

One also looks at the company differently.  Rather than charting price movements, one looks at the business.  How profitable is the business line?  Who are the competitors?  Does the company have a unique market advantage?  How much room remains for growth?  How talented is the management team and how invested are they in the company’s success?   If held for a long time, what will be the return (dividends) of the company?  Is there a better place to put one’s money?  Is the debt level manageable (no debt often points to a well-run company that has a lot of ability to take advantage of opportunities).

Investing in businesses, one would also tend to concentrate holdings more than one would when trading stocks.  Advisors often recommend holding many, many different companies for diversification, which protects against volatility in individual stocks.  If one were buying into businesses, however, one wouldn’t put money into every place on the block.  One would be very selective and just pick a few businesses (more than just one because things do happen). 

The added level of screening helps to guard against picking the bad companies, allowing one to concentrate more than is generally recommended (although one should never put more into an individual stock than one is willing to lose).  As one does well and the value of one’s portfolio grows, one would invest in more businesses, just as someone buying real estate would buy more properties as finances expand.

It is possible to become wealthy investing in stocks.  It requires that one thinks like a partner and invests in bussinesses, however, rather than trading stocks.  One needs to raise enough money to make substantial investments and one needs to have a long-term outlook.

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Calculate Investment Return

Compound interest confuses most people.  very few people can figure out what their car payment will be, the amount of interest they will pay on their house, or what their bank account will be in ten years.  Fortunately, for the last question, there is a simple method called the “Rule of 72.”

The Rule of 72 goes like this:

Take 72 and divide by the interest rate.  That will give the number of years it will take for your balance to double at that rate.  After that, just keep doubling to find you balance.

For example, let’s say you invested $2000 in a mutual fund when your child was born for his retirement (a very smart thing to do, as we shall see).  Stocks have returned between 10-15% since about 1900.  Assuming this rate of return remains (Let’s assume a 12% rate), your child’s account will double about every 72/12 = 6 years.  This means the account will double at about age 6, 12, 18, 24, 32, 38, 44, 50, 56, 62, and 68, or 11 times. 2*2*2*2*2*2*2*2*2*2*2 = 2048.  This means that your $2000 will be worth 2048*2000 = $4,096,000 at age 68.  Leave it in another 6 years, and it will be worth $8,192,000.  This means that you can effectively provide for your child’s retirement with an investment of about $5000 (worth $40M at age 68) when that child is born (assuming you can keep him from spending the $40,000 he will have at age 18 on beer in college).

Let’s say that instead of investing, you leave the money in a CD yielding an average of 3%.  Using the rule of 72, one sees that it will take 72/3 = 24 years to double.  The account will therefore double at age 24, 48, and 72.  The value would therefore be $2000*2*2*2 = $2000*8 = $16,000.  Comparing the figures, one can easily see the importance of investing in stocks for long-term investing.  For the sake of “security” one is giving up over $4 million by not investing.  And this assumes no inflation.

Finally, any regular reader will know that I have been harping on how terrible Social Security is.  Currently, after working for about 45 years, one receives about $1200 per month for as long as one lives.  If one dies, all of the money goes away.  Assuming you live to be 75 and start receiving Social Security at age 65, this would amount to about 12*$1200*10 = $240,000 in benefits.  If you were instead able to take your first year’s worth of payments (about $6000 for a $50,000 per year job) and invest in a mutual fund, your money would double every 6 years, at age 24, 30, 36, 42, 48, 54, 60, and 66.  Your balance would then be 256*$5000 = $1,280,000! 

Note this is just your first year’s payments – not including the other payments of $5000 per year made the rest of your working life. This money would also go to your hiers if you died.  If you feel this is as much of a crime as I do, please tell your Senator.

The President’s Budget and the Home Budget – Lessons to be Learned

In presenting his proposed budget to Congress and the nation, President Obama said that while various cuts were needed due to the size of the deficit and national debt, investments were needed as well.  Today I will look at various aspects of that budget as they relate to saving and investing and see what can be learned for preparation of the home budget.

Currently the US Government is in debt by about $14 T dollars.  While that is an incomprehensible number, broken down on a per capita basis to pay off the debt would require each man, woman, and child in the United States to contribute $35,000.  In dollar bills laid end-to-end, the sum would stretch around the Earth over 31,000 times.  While the debt of the average household would not even make it into the round-off error of the national debt, many families also carry a considerable amount of debt.

Generally it is true that investing is the way to become wealthy, but getting out of debt is needed before investing for most individuals.  The reason is though the US Government can (for the time being) borrow at very low interest rates, much of the debt Americans hold is in credit card accounts.  The interest rates charged by these cards are so large that there is no way one could make enough of a return from stocks or other investments to outpace the interest paid.  It makes no sense to gain a 10% return in stocks while paying 20% to a credit card company.  Just think of each dollar used to retire this debt as an investment making 20%.

As with the federal debt, the way to stop building up debt and get to the point where one can invest is to cut expenses to the point where the amount of income received is less than expenses.  The surplus can then be applied to the debt.  In particular, one would want to reduce recurring expenses since these tie up cash flow, reducing the amount available each month to reduce debt and eventually invest.  For the Federal Government this means reducing things like the federal workforce, retirement benefits, and entitlement programs – things that require funding year-after-year.  For the household this means eliminating cell phone bills, subscriptions, car leases and/or payments, and other clubs and services which hit the credit card each month on autopilot.  One wants to get control and make a conscious purchasing decision each month (there is a reason companies and businesses like auto-pay).

The second aspect to look at is the “investments” presented.  An investment, also known as an “asset,” is something that will provide income in the future, thus increasing the amount of money coming into the household.  Often people believe things to be investments which really either tread water, neither going up or down in value, or actually are expenses.  The three investments specified by the President are education, high-speed rail, and green energy.

It is true that having a population that is reasonably educated will possess the skills needed to perform various useful functions.  That in turn can build wealth for the country in the form of increased business activity and therefore increase income taxes.  Increased spending on education so far, however, has not resulted in on improvement in results.  For example, since the 1970′s spending per student has more than doubled, yet student achievement has not increased (see http://www.heritage.org/research/reports/2008/09/does-spending-more-on-education-improve-academic-achievement, for example).  Increased spending on education therefore appears to be an expense rather than an investment unless the monies could somehow be used differently to provide better results.

In the household, many see going back to school as a way to increase income.  While this can be true, particularly for individuals who have only a high school education or who wish to get into a field requiring specific certifications, many continually return to school, paying large amounts of money while never actually increasing income levels.  Before starting a new program, check with those who actually work in the industry about what diplomas and education are required.  Also ask where they tend to find people to hire.  If the school you are looking at attending is not regarded well by those hiring, returning to school will be a waste of time and money.  Also note that most entrepreneurs - those who tend to make the most money in the country - were only C students and only completed high school.  Providing more effort and taking a bit more risk may prove to be better than more education.

High speed rail also appears to be an expense and a luxury rather than an investment.  Once purchased the system will decline in value each year and require constant maintenance.   While it is true that some cities are congested and there is an opportunity loss due to people sitting in traffic, it is unclear how moving people between cities by train would lead to increased economic activity.  In particular, with more and more business going online and teleconferencing becoming more popular, it seems like investing in more bandwidth capacity would make more sense that investing in the movement of people.

The household equivalent to buying high speed rail is the purchase of a new car.  If one buys a new car it will go down in value very rapidly in the first few years.  It will also require constant maintenance – a recurring expense – and never actually add income.  When buying a car, buy one that is at least a few years old so that the depreciation loss is less per year and only buy as much car as is really needed.   Always limit the amount of money spent on things that go down in value.

If renewable energy production methods were found that would allow power to be produced at lower rates than traditional methods, that would result in increased activity.  By lowering the cost of power and thereby the cost of doing business, businesses that are not currently economically feasible could be started, leading to all sorts of opportunities.  Unfortunately most of the spending is being targeted at rolling out green power using current methods.  These methods cost more per unit of power produced than traditional methods.  Doing this and then forcing people to use this more expensive power will result in a slowdown in business activity, and thereby a loss to the government in tax receipts.  A better investment would therefore be in research to develop less expensive ways of making power.  This must be possible since renewable sources don’t have the expense of findign and processing fuel.  Once these improved techniques were discovered, market forces would lead to their widespread use without further government spending.

In summary, the household can learn from the Federal Budget.  In particular, 1)Put investing on hold until debts are paid off, and 2) Be careful when choosing investments.  Make sure that they will actually lead to increased income in the future. 

To ask a question, email  vtsioriginal@yahoo.com or leave the question in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing